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Concept
Discounted cash flow
Summary
The discounted cash flow (DCF) analysis, in finance, is a method used to value a security, project, company, or asset, that incorporates the time value of money.
Discounted cash flow analysis is widely used in investment finance, real estate development, corporate financial management, and patent valuation. Used in industry as early as the 1700s or 1800s, it was widely discussed in financial economics in the 1960s, and U.S. courts began employing the concept in the 1980s and 1990s. Related is the carbon discounted cash flow, which integrates climate-related considerations.
In discount cash flow analysis, all future cash flows are estimated and discounted by using cost of capital to give their present values (PVs). The sum of all future cash flows, both incoming and outgoing, is the net present value (NPV), which is taken as the value of the cash flows in question;
see aside.
For further context see ;
and for the mechanics see valuation using discounted cash flows, which includes modifications typical for startups, private equity and venture capital, corporate finance "projects", and mergers and acquisitions.
Using DCF analysis to compute the NPV takes as input cash flows and a discount rate and gives as output a present value. The opposite process takes cash flows and a price (present value) as inputs, and provides as output the discount rate; this is used in bond markets to obtain the yield.
Discounted cash flow calculations have been used in some form since money was first lent at interest in ancient times. Studies of ancient Egyptian and Babylonian mathematics suggest that they used techniques similar to discounting future cash flows. Modern discounted cash flow analysis has been used since at least the early 1700s in the UK coal industry.
Discounted cash flow valuation is differentiated from the accounting book value, which is based on the amount paid for the asset. Following the stock market crash of 1929, discounted cash flow analysis gained popularity as a valuation method for stocks.
Official source
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